How The SiriusXM-Pandora Deal Would Impact The Music Business

ISSUE 22 2018 - DO NOT REUSE!!! ONE TIME USE ONLY
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After satellite radio juggernaut SiriusXM announced it had agreed to acquire internet radio giant Pandora Media Sept. 24, many music executives are still unsure whether the combined superpower would use its force for good or evil, with respect to the music business's interests.

There are plenty of reasons to be optimistic about a music-dependent company that would have reaped $6.83 billion in revenue in 2017, with 36 million SiriusXM subscribers in North America and another 23 million trial listeners in cars, plus over 70 million Pandora listeners including 5.5 million paid subscribers, according to each company's 10-K filing for 2017. The deal would immediately let the services promote each other while strengthening finances and funding technology improvements for Pandora and enhancing Sirius' position in the radio market. In a statement, SiriusXM said the combined company will let it leverage exclusive content and programming with Pandora's ad-supported and subscription tiers to create unique audio packages while also using SiriusXM's extensive automotive relationships to drive Pandora's in-car distribution.

"In general, we are positive about [the deal] because it puts more weight behind a premium paid-subscription competitor [Pandora] who is still kind of small on the margin," says one major record label executive, adding that his label had seen the deal coming ever since SiriusXM had invested $480 million for a 19 percent stake in Pandora in June 2017.

But another major-label executive says his company is still taking a wait-and-see approach until it learns more about SiriusXM's plans. If the satellite broadcaster remains in the digital music space, the deal looks good for the industry, adds the executive. But if this is just the first play in a plan by Liberty Media — which owns, along with its affiliates, 70 percent of outstanding shares of SiriusXM and 35 percent of Live Nation — to roll up all three companies into one gigantic music conglomerate with divisions in touring, ticketing and artist management, "then we would be concerned," he adds.

SiriusXM CEO Jim Meyer sidestepped that question when asked if such a roll-up is an eventual possibility during a conference call with Wall Street analysts on the day the deal was announced. "We're going to concentrate a lot on making sure that Pandora and SiriusXM go together successfully," said Meyer. "I can tell you, you've done the math, we certainly have the firepower to do other things if we want to. That's not on my mind right now."

Another music industry concern: Will SiriusXM keep Pandora's interactive, on-demand offering or dump it?

Pandora's paid subscription model is growing slowly, with 5.5 million subscribers at the end of 2017. Most of them were for the ad-free custom radio tier, not the premium, on-demand tier. Yet the company is generating a lot of the on-demand streaming that has been driving the music industry's boom. In May, music executives estimated that Pandora accounted for about 13 percent of audio on-demand U.S. streams, thanks to its premium tier and a promotional offer for its paid, ad-free midlevel tier it offers to mobile users; it provides them a half-hour of on-demand service in exchange for watching 15- to 30-second video commercials, which bring in higher ad rates. Those plays also pay higher rates — about $0.004 per stream — compared with the paid subscription rate determined by the Copyright Royalty Board (CRB) of $0.0023 per play for 2018, sources say.

During the conference call, an analyst asked if Pandora's paid subscription business makes sense. Meyer said he doesn't yet know "the right answer." He added that between both companies' platforms, there are a range of options to test before settling on a solution that optimizes cash flow and earnings before interest, tax, depreciation and amortization.

While SiriusXM executives have long been enamored with Pandora's advertising revenue-generating machine, from afar, they have wondered about the need for Pandora to enter the on-demand streaming business, sources have told Billboard. Not only did that move put Pandora up against firmly entrenched Spotify, Apple Music and YouTube, it also opened the company up to paying higher royalties due to the direct deals with the majors it had to make to enter that business.

SiriusXM fights tooth and nail against every industry attempt to raise royalty rates and likely won't be happy to have to start negotiating directly with the major labels, which on-demand services must do for music licenses. Direct deals usually result in higher rates than statutory royalties set by government, whether that be from the CRB or, for performance licensing, the ASCAP and BMI rate courts.

In 2017, SiriusXM paid 11.5 percent of its revenue (excluding revenue from such content as football and talk radio) to labels and another estimated 5 percent of music revenue to publishers. Thanks to the Music Modernization Act, SiriusXM is locked into paying the labels a rate of 15.5 percent through 2027 as part of a compromise to gain SiriusXM's support for the bill.

But executives involved in the merger have already indicated they will use their combined clout to seek better rates for Pandora, which paid 55 percent of all its revenue to labels and publishers in 2017, mainly because of the per-play rates the CRB imposed on it, but also due to its direct deals with the majors and Merlin, the indie label-rights organization. Pandora's licenses come up for renewal at the end of 2018. During the conference call, Pandora CEO Roger Lynch said: "We see an opportunity to improve our gross margin by at least several hundred basis points through label renegotiations, principally around restructuring minimum guarantees as we do these renewals, and we've been making very good progress on that."

Meyer noted that the combined companies' royalty payment to the music industry is projected to be $2 billion in 2019. "We're a sizable piece of the ecosystem," said Meyer, though he noted that the SiriusXM/Pandora management teams "are committed to having a strong working relationship with the labels. Quite candidly, we need them for our product to be successful."

The deal is expected to close in the first quarter of 2019, but still needs regulatory approval. Before that, the deal includes a "go shop" provision which provides 30 days for other suitors to step up and better the Sirius offer. If that occurs, it will trigger a longer period for a deal to be constructed so that Pandora's board can weigh any subsequent deal offer against the Sirius deal. But most sources say it's unlikely another suitor will emerge because Pandora has been an acquisition candidate for almost three years.

It's also unlikely that government regulators would block the deal. SiriusXM has not been the dominant player in radio and the addition of Pandora doesn't change that, says one major label executive.

Pandora may already have improved its financial stability since selling TIcketfly to Eventbrite for $200 million sale and landing the initial investment from Sirius. But music executives still had long-term concerns about Pandora's viability, saying it still needed more funding to upgrade its technology, and this deal would help. In 2017, Pandora lost $558.4 million while generating $1.447 billion in revenue, of which $1.075 was from selling advertising while $316 million was from its paid subscriber tiers and the remainder from its sold off ticketing unit.

Meanwhile, SiriusXM is a lean, mean, cash generating machine, with net income of $666.5 million on revenue of $5.425 billion, and earnings before interest, taxes, depreciation and amortization, and other write-offs close to $2 billion. But the deal gives the gigantic satellite radio subscription service something the company had never had: a free tier. Sirius also gains access to Pandora's advertising selling capabilities -- $1.075 billion worth in 2017 -- something that Sirius had only begin to explore as a revenue stream with $160 million from that source, or less than 3% of total revenue, of $5.425 billion. Combined, ad revenue would amount to $1.235 billion.

Analysts say that Sirius can easily withstand Pandora's losses and still retain overall profitability; and then generate even more profits once it begins looking for ways to rationalize operations by eliminating redundancies and looking for efficiencies.

The best part for music executives, though: It would create more serious competition for Apple, Spotify, YouTube and Amazon. Music rightsholders get nervous when too much market share is concentrated among too few players, even though the concentration of power is a benefit that the major labels themselves enjoy.

This article originally appeared in the Sept. 29 issue of Billboard.


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